What Is a Sovereign Loan?


Quick Answer

When a government borrows money by issuing bonds in a foreign currency to foreign investors, it is called a sovereign loan, explains Investopedia. For example, a developing country may issue bonds in U.S. dollars to borrow from investors in the United States.

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Full Answer

Because the loan is guaranteed by a government, it is called a sovereign loan. The government invests the funds in development projects in the country. To bondholders, the risks and safety of the investment depends on the economic status of the issuing country and the stability of its government, notes Investopedia. A sovereign loan to a developed country is safer than one to a developing country.

Fluctuations in the rate of exchange between the foreign and native currencies can make it difficult for a government to repay a sovereign loan. If development projects don't result in the anticipated economic growth, a government may have difficulty repaying the loan. Under these circumstances, investors cannot seize the lender's assets. The only recourse is to renegotiate the terms of the loan, notes Investopedia.

If a country defaults on a loan, it will have difficulty in obtaining sovereign loans in the future. Credit rating companies evaluate a country's economic and political environment to assess the risks of investing in that particular country, adds Investopedia.

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